Countless Lies and One Truth about Mergers and Acquisitions in China

Writer | Xu Muxin

Editor | Chen Zhiyan

There is a certain cheerful sentiment in the market, with an increasing number of people shouting: "The M&A wave is approaching!" Meanwhile, there are also other rational voices discussing "The difficulties of M&A": difficulties in finding targets, difficulties in finding buyers, difficulties in closing deals, difficulties in negotiations, and difficulties in operations.

On one side is the dream, and on the other side is the reality.

But for the Chinese business world that has entered the era of stocks, M&A is a wave that must be headed towards anyway. So, in 2024, which is referred to as the "first year of M&A" by the majority, are the players prepared?

In the past two months, "Dark Undercurrents Waves" interviewed some PE investors and intermediaries, and attempted to analyze the M&A market of this year with a 10,000-word lengthy article:

Why do 80% of M&A fail?

Where exactly are the buyers?

What kind of companies wish to / are more likely to "sell themselves"?

What can VC/PE, which is struggling with assets to be exited, do in this process?

And, when will we truly usher in the spring of M&A?

Has the "M&A Wave" Arrived?

> Fact 1: The "False Prosperity" in Contrast

1. In the first half of 2024, the number of M&A transactions in the Chinese M&A market was 362, with a year-on-year growth of more than 70%. It seems that the number of transactions has soared, but in fact, it has only returned to the level of the first half of 2022.

2. The special year of 2023 has played the role of a "control group". In the M&A market, whether it is the transaction amount or the transaction frequency, compared with two years ago, 2023 is at the "halved" level. Its bleakness is caused by a combination of multiple factors, including the end of the epidemic but the economic recovery being less than expected, geopolitics, global interest rates, and the decline in the stock and real estate markets. Wang Chao, the founder of Blue Bridge Capital, told "Dark Undercurrents Waves": In 2023, he witnessed everyone going on crazy business trips from the beginning of the year, even chartering planes to go overseas for inspections, being physically and mentally exhausted but not obtaining rewards, so they "lay down one after another" in the second half of the year.

3. In the Chinese market in recent years, almost every year has been called the "first year of M&A". But looking at the history, there have only been three intensive M&A periods in China after the millennium. Moreover, after entering the era of the mobile Internet, M&A has rarely appeared in the mainstream investment context:

>  The first time was when China joined the WTO, state-owned enterprises joined the global competition game and urgently needed reform. During this period, classic cases include Newbridge Capital taking over Shenzhen Development Bank, and Hony Capital integrating China Glass, etc.

>  The second time was when foreign capital came to China to acquire factories or local brands. During this period, a classic case is the acquisition of Nanfu Battery.

>  The third time appeared after 2010. At this time, M&A is more like a low-probability event, such as Yingde Gas Privatization, Hillhouse Capital acquiring Belle, KKR acquiring China NVC, etc.

4. There are two "plus points" for 2024 to become the "real first year of M&A": On the one hand, the introduction of policies such as the "Six M&A Policies" and the "Nine National Policies" has provided systematic support for the activation of the M&A market. On the other hand, the entire venture capital environment is shifting from an era of increment to an era of stocks. Seeking opportunities in the stocks is a required course for almost everyone.

5. Li Gang, a partner of EC Capital, summarized to "Dark Undercurrents Waves" that for a track to have more "M&A waves", several conditions need to be met: This industry needs to have experienced rapid development and attracted a large amount of capital investment. In the subsequent downward cycle, there will definitely be many M&A opportunities. The innovative drug track with frequent M&A this year is a proof. Where will the next track be?

> Fact 2: Some "Big Guys" That Need to Be Discussed Separately

1. One of the important reasons why 2024 is called the "first year of M&A" is several high-profile large transactions. This includes Ye Guofu of Miniso acquiring 29.4% of Yonghui Superstores for 6.3 billion yuan, and Genmab acquiring Pufang Biology in a 13 billion all-cash transaction, etc.

2. But it is precisely because these large transactions are scarce that they are impressive. Taking the transaction of Pufang Biology as an example, in the first three quarters of 2024, a total of 30 transactions occurred in the biomedical field, with a total amount of 27.838 billion yuan. This single transaction of Pufang Biology accounts for nearly half. The transaction with the second-largest transaction amount is Fosun Pharma's 5 billion yuan acquisition of Henlius. That is to say, the remaining 28 transactions amount to less than 10 billion yuan in total, not as much as that one transaction.

3. The transaction volume of the primary market in the third quarter of 2024 is 224.1 billion yuan, seemingly a significant recovery. In fact, there are several large transactions, including the 60 billion yuan financing of Dalian Xindameng and the 23 billion yuan financing of Huawei Yinwang Intelligence. Excluding these events, 900 companies have competed for a total of 19.1 billion yuan in investment.

> Fact 3: M&A Exit? More Sellers Than Buyers

1. Currently, VC/PE funds have 130,000 projects and 14,000 companies with assets to be exited. In the first three quarters of 2024, a total of 127 Chinese companies went public at home and abroad, accounting for 0.9%.

2. In 2023, among the 14 trillion yuan in the primary market stocks, the amount recovered through M&A is 60.506 billion yuan, accounting for 0.4% of the total amount.

3. According to Pitchbook and Zero2IPO Research Center data, in 2023, compared with the United States where the exit through M&A accounted for 95%, only 46% of the transactions in China were exited through M&A. And the fundraising and investment ratios of M&A funds in the United States are 68% and 69% respectively, while these two figures in China are only 3% and 1%.

"The claim of the 'M&A Wave' is tempting, but it is a lie."

No one can be young forever, except for the first year of M&A.

The popularity of the claim of the "M&A Wave" is more like a collection of expectations and even wishes. Investment institutions are making wishes because they want to exit; companies that urgently need to be sold are making wishes because they hope there will be more buyers; intermediaries are making wishes because any "wave" is a significant benefit to their business model.

However, the M&A market is not the A-share market. The huge transaction amounts involved and the complex processes make it impossible for any irrational factors, emotions, or speculations to truly affect the decisions.

Li Gang of EC Capital told "Dark Undercurrents Waves": Looking at the development of Chinese business, 2024 is the first time that there are so many assets to be exited. Currently, the number of funds in the exit and extension period exceeds 37,000, with a scale of up to 15 trillion yuan, while "the entire health industry is only 10 trillion yuan".

However, the pace of IPOs has slowed down at this time, coupled with the factors of the global economic recession, almost everyone is frantically looking for a way out. Leaving aside the more under-the-table practices such as selling old shares and buybacks, there are only two mainstream exit methods. Since IPOs cannot be considered, naturally everyone is eyeing M&A.

But obviously, the M&A wave will not come just because people are keeping a close eye on it.

Why Does M&A Fail?

> Fact 4: Failure to Reach an Agreement on Price Is the Core Factor

1. The transaction price of M&A is falling: According to statistics from Chang Lei Capital, in the A-share M&A transactions in the past two years, the number of transactions with a post-M&A valuation of less than 500 million yuan accounts for more than 50%.

2. The valuation model has undergone a fundamental change: Currently, the M&A party mostly uses PE (Price-to-Earnings Ratio) pricing, which is the multiple of the net profit of the target company, representing the time required to recover the investment cost. For example, a 10-times PE means recovering the investment cost in 10 years. The benchmark for listed companies' M&A is about 15 times. In the Internet era, the M&A party basically only used PS (Price-to-Sales Ratio, valuation / sales) to measure the price. This is because many Internet companies are in a loss-making state during the high-speed growth period, but the company usually experiences an explosive growth after the money-burning stage, and the value of such companies cannot be estimated by the PE model.

3. The price gap between the buyer and the seller is not formed in one day: It is bitter and unacceptable for companies that have emerged from the capital wave in the past decade to accept the current M&A valuation system, just like the inversion of valuations between the primary and secondary markets in recent years.

4. M&A cases that failed due to price: In August 2024, Ni Kai, the founder of the autonomous driving company Hodo Technology, admitted that the M&A and reorganization with GAC failed. The core reason is that GAC did not follow Hodo Technology's valuation of 3 billion yuan, but discounted it to a valuation level of several hundred million yuan. Two years ago, the valuation of GAC's leading investment in Hodo Technology's C+ round was several hundred million yuan.

5. Selling at a loss: The bitter reality is that the prices of companies that have been sold recently cannot be compared with their peak moments. The listed company Jifeng shares sold its controlling company "TMD" at a 20% discount and undertook a maximum loss of 380 million yuan. Selling at a loss has become the consensus of many target parties. Si Rui Pu acquired 100% of the equity of Chuangxinwei for 1.06 billion yuan, and the last-round valuation of the latter was 1.31 billion yuan. Such a large price gap is not uncommon, but the Chuangxinwei acquisition case is a special case because it adopts a differentiated pricing and evaluation value plan, and the difference is transferred by the management team shareholders of Chuangxinwei, ultimately achieving a win-win situation for all parties.

> Fact 5: There Are Still Many Objective Obstacles

1. The policies are still on the way

Previously, there were many restrictions on especially listed companies and private equity companies. Including that private equity cannot participate in the M&A and reorganization of listed companies, and listed companies cannot acquire companies across borders or acquire loss-making companies, etc.

However, since this year, a series of policies related to M&A have been continuously introduced, including the 32 Policies on Shanghai Equity, the New Nine National Policies, the 17 Policies on Venture Capital, and the Six M&A Policies, etc.

However, among the interviewees, most people said that although the introduction of policies is a good thing, there is still a gap in the actual promotion of M&A. "It is not about the introduction but the implementation, especially waiting for the window guidance from the China Securities Regulatory Commission", which is the cautious judgment of most people.

In addition, banks have begun to adjust the traditional credit thinking in the M&A loan business and explore ways that are more in line with the market demand. Yu Tong, the general manager of One Village Capital, told "Dark Undercurrents Waves" that currently, banks still mainly focus on the cash flow, dividends, interest, and other indicators of the target to be acquired. Although this model is effective in risk control, there is still room for optimization in the face of the increasingly complex and diverse needs of the M&A market. Currently, some banks have moderately relaxed the requirements for cash flow and loan repayment according to the actual situation of enterprises, creating more possibilities for the further development of the M&A business.

2. The "IPO Complex" of Chinese Founders

The "protective mentality" of founders towards their enterprises is another factor that affects the willingness to sell. In the observation of Wang Chao of Blue Bridge Capital, Chinese entrepreneurs attach more importance to IPO. In contrast, American entrepreneurs have a higher acceptance of selling their companies, and they would rather cash out and leave than continue. This is also because American VCs attach more importance to the ability to "sell the company".

Zhang Xinzhao, the founding partner of Qicheng Capital, used "entrusting an orphan" to describe the mentality of founders accepting M&A. Therefore, the M&A buyers represented by Buffett pay particular attention to maintaining their reputation on a daily basis to prove to the other party when buying the target - I will treat your company well.

In 2006, Huang Guangyu found Zhang Jindong and said he wanted to acquire Suning. Zhang Jindong replied: "I won't sell, and you can't afford it; if I can't beat you, I'll give it to you for free, without you buying it." Zhang Jindong's words represent the thoughts of many entrepreneurs, that is, seeing the sale of the company as a failure, and going public is the perfect ending.

3. Lack of Sufficiently Experienced Local M&A Funds

The failure rate of M&A is 80%. According to Hu Xiaoling, the founding partner of CDH Investments, this 80% failure rate refers to the failure rate after the money has actually been spent, and does not include the "failure rate" of hoping to acquire a target but not being able to buy it.

We have discussed in the article "Buyout in China" that compared with the equity investment teams that have gradually matured with the rapid growth of wealth, there are no more than 50 people in the whole of China with mature M&A leadership experience. These include "M&A Queen" Liu Xiaodan, as well as Zhang Yong (Xiaoyaozi) who joined Chenyi Investment, Hillhouse Capital that delisted and re-listed the "Shoe King" Belle, CDH, and One Village, etc. However, compared with the countless names in the equity investment field, these successful PE are more low-key, like "sweeping monks".

And the legendary stories of foreign PE are even more dazzling. In 2013, under the double blow of the melamine incident and the fraud of Chinese concept stocks, the stock price of Feihe slumped. Therefore, Morgan Stanley RMB Fund invested 29% of the equity of Feihe Dairy at a PE of 7 times and helped it delist from the NYSE. Later, it suggested that Feihe focus on high-end milk powder, and finally made it re-list after 6 years. With an investment cost of 200 million yuan and an investment return of 100 times, Feihe Dairy has become the most profitable project of Morgan Stanley Asia PE Fund so far.

Shan Weijian, who led PAG to acquire the state-owned banks in South Korea during the Asian Financial Crisis, later acquired Yingde Gas at a price of 6 Hong Kong dollars per share when it was poorly managed. PAG implemented a series of new measures for Yingde Gas to reverse the decline in its operations.

However, in recent years, the number of foreign PE's investments in China has been decreasing. Among them, Advent International and Bain Capital are the only two top PE that have reached deals this year, and the latter has acquired the shares of two manufacturing companies.

"The fundamental difficulty of M&A in China is the difficulty of transformation."

The golden rule of M&A is: Every Deal is a right deal at right price. There is no deal that cannot be done, only a price that cannot be reached. For many companies, the price decline may be the inevitable result of the capital bubble in the past decade. After experiencing the inversion of valuations between the primary and secondary markets and the obstruction of IPOs in the past few years, for a large number of enterprises that expect to